What Can We Learn from Netflix?

There was a time when Netflix could seemingly do no wrong: Movie lovers would wait anxiously for their next iconic red envelope containing yet another DVD to enjoy. But times have certainly changed. Today, the reviews of Netflix’s services — both its DVD-by-mail and online streaming video — are mixed at best. The company became the subject of consumer ire after separating both services last year and raising subscription prices — and it has yet to recover from that. “Netflix lost a lot of momentum when it went to two-tiered pricing, and it did little to regain that momentum,” notes Wharton marketing professor Eric Bradlow.

Meanwhile, competition is intensifying as Hulu, DirecTV, Amazon and others are racing to offer exclusive content that Netflix subscribers don’t have access to. “There is tremendous competition out there for ‘digital eyes,’ and it really is about who has the best content,” Bradlow says.

According to an article in The Wall Street Journal, the company’s DVD service — which is three times more profitable than its online subscriptions — has been losing close to one million subscribers per quarter. In the most recent quarter, the company lost 850,000 DVD subscribers, while only adding 530,000 to its online streaming service. Factor in the cost of acquiring new subscribers overseas (the company is focusing on expanding globally) and the need to source expensive new content to keep its online subscribers engaged, then it’s no surprise that the firm reported a 91% decline in net income in late July.

Many observers agree with Bradlow that if Netflix is to survive, content will be key. Wharton marketing professor Jehoshua (Josh) Eliashberg, for example, suggests that the firm could begin developing original content — similar to HBO — “based on its subscribers’ demonstrated preferences, which is a treasure.” (In fact, Netflix has already begun exploring this path: Its first original series, “Lilyhammer” — about a New York mob boss beginning a new life in Lillehammer, Norway — debuted in early 2012.)

Wharton management professor David Hsu says that although bolstering its media offerings will be critical for Netflix, this will be difficult to do. While the cost of acquiring or developing new content is not fixed and will most likely increase, “consumers have become accustomed to the ‘all you can eat’ streaming video revenue model for a low fixed price each month.” One solution, he suggests, could be found in Netflix’s DVD-by-mail service, for which subscriptions are priced based on the number of DVDs out at a time. “I think the company should try to develop an analogous tiered pricing scheme on the streaming side of their business. This could involve rights to certain premium titles, or perhaps [be] segmented by … the number of watching hours, etc. This will not be easy, however, as we witnessed when Netflix moved to reform its pricing structure in the past.”

There is a critical lesson here for anyone looking to launch a new business, Hsu adds. “Entrepreneurs, particularly in new industries, should think carefully about the importance of getting the initial revenue model ‘right’ — versus to what extent the market will be more forgiving if the company pivots from its initial revenue model.”

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